HUNTINGTON INGALLS INDUSTRIES, INC. annual report, FY2022

Business context and reporting period

Huntington Ingalls Industries, Inc. (NYSE: HII) filed this Form 10-K for the fiscal year ended December 31, 2022. Although the request references 2022 Q4, the supplied filing reports full-year results; it does not provide a clear standalone fourth-quarter financial summary.

HII operates Ingalls and Newport News shipbuilding and Mission Technologies, serving primarily U.S. government customers. The company reported approximately 43,000 employees; more than 95% of revenue came from the U.S. Government, and approximately 82% came from the U.S. Navy in 2022.

Financial and operating performance

Metric	2022	2021
Sales and service revenue	$10.676 billion	$9.524 billion
Operating income	$565 million	$513 million
Net earnings	$579 million	$544 million
Diluted EPS	$14.44	$13.50
Operating cash flow	$766 million	$760 million
Free cash flow	$494 million	$449 million

• Revenue increased 12%, operating income 10%, net earnings 6%, and diluted EPS 7% year over year. Operating margin was approximately 5.3%, versus 5.4% in 2021; net margin was approximately 5.4%, versus 5.7%.
• Revenue growth included a $911 million increase in Mission Technologies, primarily reflecting the 2021 Alion acquisition. Newport News revenue increased 3% and Ingalls revenue increased 2%.
• Segment operating income rose 4% to $712 million: Ingalls $292 million, Newport News $357 million, and Mission Technologies $63 million. Mission Technologies’ segment margin declined to 2.6% from 3.4%, in part due to Alion-related intangible amortization.
• Net cash provided by operations was nearly flat. Free cash flow increased to $494 million, partly due to lower pension contributions, lower capital expenditures, and favorable working-capital timing.
• Cash and cash equivalents were $467 million at year-end, down from $627 million. Current assets were $2.746 billion and current liabilities $2.895 billion.
• Debt totaled $2.905 billion, including $399 million classified as current; the company reported $1.486 billion available under its revolving facility and no commercial-paper borrowings. Debt covenants were met.
• Total backlog was $47.1 billion, down from $48.5 billion; $22.2 billion was funded and $24.9 billion unfunded. The filing expects approximately 22% of year-end backlog to convert to revenue in 2023.

Material changes and unusual items

• 2022 revenue growth was concentrated in services, which rose 34% to $3.393 billion, principally due to Mission Technologies and the Alion acquisition. Product sales rose 4% to $7.283 billion.
• Net cumulative catch-up revenue adjustments added $113 million to operating income and $2.22 to diluted EPS in 2022. Favorable items included Columbia-class submarine incentives and risk retirement on selected amphibious ships; unfavorable items included estimates on Virginia-class submarines, the USS George Washington refueling overhaul, and the John F. Kennedy carrier.
• Operating income and segment operating income differ materially because of pension accounting. The operating FAS/CAS adjustment was a $145 million expense in 2022; management expects an approximately $68 million operating FAS/CAS expense in 2023.
• The effective tax rate increased to 19.5% from 12.5%. The filing says the 2022 R&D tax amortization requirement reduced operating cash flow by $102 million and estimates an approximately $82 million reduction in 2023, subject to potential legislative changes.
• Year-end pension plans were 109% funded on a FAS basis, compared with 102% a year earlier. Higher discount rates reduced benefit obligations, while plan asset returns were negative 16.1% in 2022.

Outlook, risks and contingencies

• Management stated that expected operating cash, existing cash, and borrowing facilities should be sufficient to meet obligations and fund capital expenditures for at least the next 12 months and beyond, based on current plans. It did not provide an earnings or revenue forecast in the supplied filing.
• Expected 2023 capital expenditures were approximately 1.5% of revenue for maintenance and sustainment and 1.5%–2.5% for discretionary investment. Expected 2023 contributions were less than $1 million to qualified defined-benefit pension plans and approximately $35 million to other postretirement plans.
• The FY2023 defense authorization and appropriations supported major ship programs, including destroyers, Virginia-class submarines, LPD 32 and Fallujah (LHA 9), and provided advance procurement funding for additional ships. Management nevertheless cited uncertainty in future defense budgets and award timing.
• Management highlighted labor shortages, supplier constraints, inflation, schedule and cost pressure, and uncertainty related to geopolitical conditions and COVID-19 effects. These may increase contract costs or delay performance; fixed-price contracts expose HII to costs it may not recover.
• In August 2022, the Navy identified a significant deficiency in Ingalls’ property management system and withheld 2% of payments on certain invoices under one contract, pending correction. HII said it could not assure the outcome.
• In January 2023, HII began discussions with a Mission Technologies customer to amend a contract addressing manufacturing issues; a possible amendment could result in future losses of up to $25 million.
• COVID-19 insurance recovery claims remained unresolved. The Vermont Supreme Court allowed the company’s claim to proceed; ultimate recovery is uncertain. Other disclosed matters include a False Claims Act appeal, asbestos claims, and enforcement of a Venezuela arbitration award; the filing does not indicate that these matters were expected to have a material financial effect.
• Mission Technologies goodwill was $1.7 billion, and its estimated fair value exceeded carrying value by approximately 5% at the annual impairment test; no impairment was recorded. Deloitte identified long-term shipbuilding contract revenue estimates and Mission Technologies goodwill valuation as critical audit matters. The auditor gave an unqualified opinion on the financial statements and internal controls.

Important facts for investors to verify

• Whether labor availability, supplier performance, inflation, and production schedules affect contract costs, ship deliveries, or estimated margins.
• How much of the $24.9 billion unfunded backlog receives appropriations and converts to funded orders and revenue.
• Whether Mission Technologies meets the assumptions supporting its narrow goodwill valuation cushion and improves its segment margin.
• Progress in resolving the Ingalls property-system deficiency and payment withhold, and the outcome of the potential Mission Technologies contract amendment.
• Cash-flow effects of tax-law changes, working-capital timing, pension assumptions, planned capital spending, and the $400 million debt maturity in 2023.
• Whether the positive 2022 cumulative catch-up adjustments and contract incentives are repeatable; these estimates depend on management’s contract cost and risk assessments.